September 2022 Edition!

Ndawo Victorine | Doctorate in Quantitative Finance | Part 2/2

Mistake 3: Not determining the investor’s risk preference. Risk and uncertainties are avoidable aspects of all investments and they play a vital role in economic life and decisions. As a result it is important to understand the individual’s attitude towards risk. Otherwise, it could lead to investment mistakes and failure. Risk preference is one of the key ingredients that determines the financial decision of the investor or entrepreneur. They play a crucial role in: • Shaping the needs and demand for the type of debt requested. • The frequency at which the stocks/assets are traded. They also influence the acquisition of financial information.

When the risk preference of investors are well understood, it will determine and serve as a guidance that will order the choice and model of the portfolio generated. It may also form some sort of foundational guide lines to asset prices (Firth, 2015). It could contribute highly to the assessment and mitigation of financial mistake like not participating in insurance schemes and financial market. Once more, it helps to provide a conscious assistance to financial advisors and intermediaries to adhere with the protection of regulatory measures that often require adequate measurement and evaluation of risk preference before engaging to allocate any form of financial advice, (Guiso, 2013). Risk preference are the core to theories that govern the choice of the portfolio. Let’s observe the model below for risk preference:

Ω_i = (Er_i^e)/(λ_i γ_i^2) Source of equation: Household Finance; An Emerging Field, (Guiso, 2013). Where Ω_i Is the risky asset of the investor I Er_i^e is the excess return of the investor I γ_i is the parameter that captures the risk aversion; thus it gives the coefficient of the risk aversion of the individual investor λ_i is the return’s volatility of the risky security/asset. Determinants of risk preference. In this write-up, we will consider only risk aversion as the major determinant of risk preference. The following factors serve for the determinants of the risk preference of an investor: • Wealth, investments and some factors on the environment. • The trend of risk aversion: this consist of looking on low risk aversion changes as time goes on. • The study of the sensitivity of taking financial risk with respect to investment on trading. • Consideration of some factors like regret.

Mistake 4: Over expectation or expectation based on another investor’s / advisor’s point of view In order to invest for long term, the investor has to create a portfolio of well diversified assets. The portfolio should incorporate an appropriate level of risk with all the returns inclusive. According to (Stammers, 2016), one can design the right portfolio but the returns on this portfolio cannot be controlled or predicted. If one succeeds to predict this returns or expectations, it means the market can be predicted. This is not possible. So, in order to even have an idea of what a return or expectation can be, a good idea of the goal, asset allocation must be properly understood and incorporated, (Mallouk, 2014).

Mistake 5: Buying at higher prices and selling at lower prices One of the basic principles of investing is to buy at lower prices and sell at higher prices. Many investors do not usually apply rational decisions at this point. Investors usually fall in the temptation of trying to maximizing short term returns so they sell lower than was bought.

Mistake 6: Failing to carry out adequate diversification There are so many market scenarios. So, the best way is to constitute a portfolio that is capable of appropriating the returns and the level of the risk involving all the market scenario is to diversity. Adequate diversification captures all market scenarios, (Park, 2017). Returns can be maximized by creating a large investment exposure in one asset. Even in investment one sector cannot work. This is because if the market scenario more against this asset or sector, disaster will result. According to (Partridge, 2010), even though adequate diversification is encouraged, too much of it can affect the overall performance, (Stammers, 2016). So, diversification should be balanced. In this case advice can be sought from professionals.

Mistake 7: Spending much money on fees and commissions One of the common mistakes investors commit is pay more (spending highly) on issues like advisors fees or commission. For small businesses excess expenditure on one item leads to a significantly adverse effect on the net worth; especially over a long term. Therefore, the pointer here is to be aware of all the investments decisions and their cost from the on-set of the business creation. Fund allocation for such arm should be properly figured out, (Batnick, 2018). Watching out to see if such payment for professional advice is beneficial before even engaging in it.

Mistake 8: Good trading approach: too much trading and very often One key character of an investor is the ability to patiently work until the goal is achieved. Investing is not magical. This means that one don’t just invest and it turns out as the investor thought. The investor should develop a virtue called patience. This reason is because it entails time to achieve the ultimate reward of an investment. When investment tactics is continuously being modified, the return is at risk and may not come out as thought. Also, portfolio re-composition may also be risky. The already constructed portfolio and asset class should be carefully studied and more should be learned about it. Reconfiguration can only step in after careful studies and findings, (Mallouk, 2014).

Mistake 9: Using media information Media use their news channel to generate money for themselves by broadcasting tradable materials and information. The main reason is parsing out the information out of the noise. Skilled and successful investors gather all these valuable information especially from varied media sources. They use them for studies related to their business. That is the use information for research and analysis depending on the case at hand. On the contrary, some investors turn to use the media as the only source of information for investment decision. This is an investment mistake. The reason is because, when an information is made public, any person laying hold of it, factors it into market prices. The purpose of the media is mainly for adverts not market information. So, getting news from the media and using the information for market projections is an evidence of poor trading strategy. As a result, it is an investment mistake.

Mistake 10: Focusing on high yielding assets A common seduction encountered during investment is asset or security that is producing high yield. This is really tempting because the investor is like why wouldn’t I maximize the output money? One thing that one has to put in mind is that an asset or security, producing high returns also carries high risk! Again, the future performance cannot be predicted/guessed from the previous returns. So focusing on a yielding asset is an investment error. It is better to focus on the whole portfolio than to get distracted by the yielding asset, (Stammer, 2016).

Mistake 11: Not being able to state clearly the performance of an investment Some investors may have an idea on the performance of some items but in terms of the entire portfolio, it may be challenging. It is always necessary to relate the portfolio performance to the investment plan to find out if the investment is on track especially after economic situations like inflation, after cost and accounting cost are deducted. This is the best way to determine how best the investment is faring.

Mistake 12: Not being proactive It is often said that “one can’t tell the future”. Yes! But one can do things that will shape the future. It is clear that the investor cannot control the market or order what the market will produce, but he or she can undertake some actions such as saving, continuous investment of capital for some time and so on that can bring about great influence of the future returns and wealth generation. Being proactive and taking proactive steps in the surest means of influencing the accumulation of wealth as well as the investment returns. This gives an increasing probability of attaining the financial objectives. According to Warren and Soros another proactive measure is to predetermine the exit strategy of an asset before purchasing or making the investment. Otherwise the input time, money and energy may come to naught (Warren, 2003).

Mistake 13: Getting the wrong adviser Furthermore, one of the most common investment mistakes is working with the wrong adviser. The main reason of getting a business adviser is looking for someone who will play the role of a partner to facilitate the achievement of the investment goals. If not, the adviser is of no purpose. Thus, this professional should therefore be an ideal one who will be able to: • Share in the financial service provision of the business. • Get into the investment philosophy. • Participate in the general life of the investors so that adequate advice can be given when and where necessary for success promotion. Therefore, it is greatly encouraged to avoid getting the wrong adviser. A wrong business adviser can be avoided by taking time to make deep search and findings. So that you can get a good professional-business advisor, especially the one who is specialized in your domain of investment. This would produce a long lasting and beneficial results that would avoid wrong business decisions and promote the attainment of the business goals.

Conclusion Not only do investors suffer the consequences of the business mistakes they commit, their reactions is a pointer to other investors and people admiring investment opportunities (Guiso, 2013). Also, these mistakes could offer broader implications not only to the investors but also to the environment and other people related to him, the business, community and the world at large. One of the greatest evidence is from the business performance and their sustainability. For the investment mistakes briefly described above, their evidences are short listed along side. The best form of ridding yourself from business misconception, is to first of all find out these mistakes, be aware of them and then look for ways to avoid them. This is a clear cut way of preparing to succeed in any business venture. At this juncture, it is worth stating that when these mistakes are identified and avoided it leads to: • Reduction in the stress level of the investor. • The performance of the business is improved. • Profit will be made, thus contributing partly as a means to which the goal of the business could be arrived at. • Sustainability of the business will be assured. • The quality and Lifestyle of the investor and his immediate family members are positively affected. • The community also benefit. The end

REFERENCES • Al-Janabi, N. M. (2020). Money Supply Money Demand. Researchgate, 1-26. • Baker, H. K. (2019). Navigating the Investment Minefield: A Practical Guide to Avoiding Mistakes, Biases and Traps. Emerald Insight, 21-42. • Batnick, M. (2018). Big Mistakes: The Best Investors and their Worst Investments. New Jersey: Bloomberg Press. • Ben, C. (2015). A Wealth Of Commn Sense — Why simplicity trumps complexity in any investment plan. New Jersey: Bloomberg Press. • Bodie, ZVI et al. (2013). Essentials of Investments. New York: McGraw-Hill Companies Inc. • Chuck A. Arize et al. (2016, April 19). Market Timing Technique: It’s Uses by Practioners of Money Management. Article in Accounting and Finance Research., pp. 106-110. • Firth, C. P. (2015). Household Investment Mistakes: Evidence and Avoidance. EDHEC, 5-100. • Guiso, L. &. (2013). Household Finance: An Emerging Field. Einaudi Institute of Economics and Finance via Sailustiana 62- 00187, 1397-1532. • Lei, S. &. (2015). Factors Related to Making Investment mistakes in the Down Market. Journal of Personal Finance, 34-42. • Mallouk, P. (2014). The 5 Mistakes Every investor makes and how to Avoid them: Getting Investing Right. Hoboken, New Jersey: John Wiley & Sons Inc. • Park, T. (2017). Improving Portfolio Diversification with Uncorrelated Market Exposure. Nuveem, TIAA, 1-17. • Partridge, L. (2010, August). A Diversified Approach to Diversification. (D. P. Collins, Interviewer) • Piketty, T. (2014). Capital in the Twenty-First Century. London, England: The Belknap Press of Harvard University Press. • Stammers, R. (2016). Tips for Avoiding the Top 20 Common Investment Mistakes. CFA Institute, 1-2. • Tillinghast, J. (2017). Big Money Thinks Small: Biases, Blind Spot and Smarter Investing. New York: Colombia Business School Publishing. • Warren, B. e. (2003). The Winning Investment Habits. New York, N.Y 10010: St Martin’s Press, 175 Fifth Avenue.